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Product Details
| ISBN-13: | 9781316213353 |
|---|---|
| Publisher: | Cambridge University Press |
| Publication date: | 02/02/2015 |
| Series: | Cambridge Tax Law Series |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| File size: | 2 MB |
About the Author
Victor Thuronyi served as lead counsel (taxation) in the IMF's legal department until 2013, where he coordinated the department's program of technical assistance in tax law, focusing on drafting new tax laws or on substantial revision of existing ones, as well as continuing to teach. He is the author of Comparative Tax Law (2003) and numerous articles and book chapters on tax law and policy, and he is the editor of and a contributing author to Tax Law Design and Drafting (2000).
Wei Cui is an associate professor in the faculty of law at the University of British Columbia. Prior to 2013, he taught and practiced law in Beijing and assisted Chinese government agencies on a variety of tax legislative and regulatory matters involving business and individual income taxation, the VAT, and tax administration. He served as senior tax counsel for the China Investment Corporation between 2009 and 2010, and he is a current member of the Permanent Scientific Committee of the International Fiscal Association.
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Cambridge University Press
978-0-521-85112-1 - Value added tax : a comparative approach - by Alan Schenk and Oliver Oldman
Excerpt
1 Survey of Taxes on Consumption and Income, and Introduction to Value Added Tax
I. INTRODUCTION
The VAT has spread around the world more quickly than any other new tax in modern history.1 According to Alan Tait, the value added tax “may be thought of as the Mata Hari of the tax world – many are tempted, many succumb, some tremble on the brink, while others leave only to return, eventually the attraction appears irresistible.”2 The extreme of a country that left, only to return, is Japan. It enacted a VAT in 1950, delayed its effective date for several years, repealed it in 1954, and then enacted a different version of VAT in 1988.3
This book covers value added tax and, in some parts, other consumption taxes in use or proposed in developing and developed countries. A valuable resource in electronic form that assists in locating tax legislation around the world is http:/ /www.itdweb.com, developed jointly by the International Monetary Fund, the Organization for Economic Co-operation and Development, and the World Bank.
Tax on consumption generally refers to a tax on goods and services that are acquired by individuals for their personal use or satisfaction. It generally doesnot include goods and services that are physically used or incorporated by business in the production or distribution of goods or in the rendition of services (business inputs).
It is difficult for a business to operate internationally without considering the implications of sales tax or value added tax on international trade, whether or not the company’s country of residence has a broad-based tax on consumption. For example, the United States does not have a sales tax or value added tax, except at the state and local levels of government. Nevertheless, a U.S. business operating in or shipping goods or transferring services to developed or developing countries with VATs must consider the VAT implications of exports to or imports from those countries.
This book explores value added and other consumption tax principles from a comparative perspective in the hope that this scrutiny may lead to suggestions for improving existing VAT systems and designing new ones. We will discuss VAT systems in the member states of the European Union (EU), as well as examine the implications of the EU VAT directives on domestic law in the member states. We will explain major departures from the EU model in non-European countries (especially in New Zealand, Japan, and South Africa), and highlight the wide variety of consumption tax proposals in the United States, ranging from proposals to adopt a federal VAT as an additional revenue source to proposals to replace some or most existing federal taxes with some form of consumption tax. In a later chapter, we will discuss several of these U.S. proposals. None of the U.S. proposals has been subjected to serious congressional debate. Appendix B is a theoretical VAT Act for the Commonwealth of New Vatopia that can be used as a starting point for a country interested in adopting a VAT or revising an existing VAT. It is used in this book as a reference and a source to compare VAT rules in effect in a variety of countries.4 This chapter provides background for the study of consumption taxation. It discusses direct and indirect taxes, and explores tax structures in developing and developed economies. The impetus for improvement in the taxation of goods and services is highlighted, and the basic concepts and terms used in the VAT literature are detailed.
II. DEVELOPMENT OF TAXES ON CONSUMPTION – A BRIEF REVIEW OF HISTORY
Most early forms of taxation were levies on land5 or on the produce from land. The following is only a thumbnail sketch of how the produce of land and goods have been the subject of taxation throughout recorded history. The tax on land in early civilizations was payable in kind with the produce from the land.6 The tithe in Egyptian kingdoms was imposed as a proportion of agricultural produce.7 In the days of the city-states of Athens and Rome, although there were taxes in the form of rents from state-owned land (including taxes on natural resources extracted from these lands), the rulers supplemented revenue from land with indirect taxes.8 Customs duties were imposed at the ports and taxes were extracted at the markets for goods that arrived by land.9 In the third century A.D., Diocletion imposed fees (or taxes) from the monopolies that he granted for the production and sales of goods.10
During the late thirteenth century, England imposed taxes on its wool exported by the Italian merchants who were granted the monopoly on this export. This “Ancient Custom,” as it was known, later was expanded to cover all exports of goods from England.11 In the late Middle Ages, in Italy and elsewhere, goods produced by artisans were taxed by taxing the guilds. The guilds raised the needed funds by taxing their members.12
The taxation of goods changed as firms were organized to produce goods and sell them through distributors to retailers. It became common, especially in Europe, to impose tax on business turnover (gross receipts). Thus, a cascading turnover tax was imposed every time that goods were transferred in the process of production and distribution to the final consumer. “Cascading taxes cannot be reclaimed by the purchaser, so that the tax component of the price of goods becomes larger and larger the more stages there are between producer and consumer – with obvious distortionary effects as between highly integrated enterprises and other enterprises.”13 For example, assume that a lumber mill sold lumber to a carpenter for a pretax price of $1,000. With a 1 percent turnover tax, the mill added $10 tax and charged a tax-inclusive price of $1,010. The carpenter fashioned the lumber into tables and sold the tables to a retailer. To its $5,010 pre-turnover-tax price (including the $10 tax on the lumber), the carpenter added $50 tax, for a tax-inclusive price of $5,060 (the numbers are rounded to dollars). The retailer sold the tables to consumers for a pretax price of $10,060. The retailer added $101 tax, for a tax-inclusive price of $10,161. The government collected total tax of $161 (10 + 50 + 101).
To take an extreme comparison, assume that the carpenter operated his own mill and sold his crafted tables directly to consumers. If there were no turnover tax on the mill’s purchase of trees, and if the carpenter sold the tables to consumers for pretax prices of $10,000 (because he would not bear the $60 tax imposed by the multiple turnovers), the carpenter would add turnover tax of $100, for tax-inclusive prices totaling $10,100. This comparison made in Table 1.1 illustrates some of the deficiencies of the turnover tax – the cascading of taxes and the incentive to integrate a business vertically.
| Nonintegrated | Vertically integrated | ||||||||||
| Mill sale to carpenter $1,000 × 1% | $10 | ||||||||||
| Carpenter sale to retailer $5,010 × 1% | 50 | ||||||||||
| Retailer sale to consumers | $10,060 × 1% | 101 | |||||||||
| Carpenter sales directly to consumers $10,000 × 1% | $100 | ||||||||||
| Total tax imposed & collected | $161 | $100 | |||||||||
Businesses must pay turnover tax on all purchases, that is, on all business inputs. At each subsequent turnover of goods (i.e., sale), the taxes previously paid and the values previously taxed are again subjected to tax in a process often referred to as pyramiding or cascading, or just as “tax-on-a-tax.” In the example just described, the carpenter charges $50 tax on his $5,010 sales price that includes the $10 tax buried in his $1,010 cost for the milled lumber (or, to put it differently, he collects a total of $60 of tax from the retailer, of which the $50 tax charged on the sale is paid to the government and $10 buried in the pre-tax $5,010 price is paid to his lumber supplier).
As indicated, the cascading tax element in retail sales is reduced if the carpenter vertically integrates his operations. The classic example of a vertically integrated American business was the Ford Motor Company’s River Rouge complex (in Dearborn, Michigan) that processed the steel and glass and other parts for the cars that were assembled on its assembly line. A more recent example is the Benneton company that operates its own retail shops to sell the apparel that the company manufactures.
In Germany, Dr. Wilhelm von Siemens recognized the problems with turnover taxes and developed what he referred to as the “improved turnover tax” or “the refined turnover tax.”14 Adams discussed a value added concept in the United States in 1921.15 The principle was to reduce the tax on sales by the tax already paid on business inputs in order to avoid the tax-on-a-tax effect and to remove the incentive to vertically integrate a business. The effect of this “improved” turnover tax for a nonintegrated series of businesses and a vertically integrated business is illustrated in Table 1.2.
| Nonintegrated | Vertically integrated | ||||||||||
| Mill sale to carpenter | |||||||||||
| Taxable sale of $1,000 × 1% | $10 | ||||||||||
| Carpenter sale to retailer | |||||||||||
| Taxable sale- $5,00016 × 1% | 50 | ||||||||||
| Credit for tax on purchases | (10) | ||||||||||
| Retailer sales to consumers | |||||||||||
| Taxable sale- $10,00017 × 1% | 100 | ||||||||||
| Credit for tax on purchases | (50) | ||||||||||
| Carpenter sales directly to consumers | |||||||||||
| Taxable sales- $10,000 × 1% | $100 | ||||||||||
| Total tax imposed and collected | $100 | $100 | |||||||||
This “improved” turnover tax is imposed and collected at each stage of the production and distribution of goods and services whenever there is a transaction, but the net tax liability represents only the tax on the value that has been added by the selling business at that stage. By granting a reduction in tax liability for the tax imposed on taxable purchases (the input tax credit), the tax base at each stage basically is limited to the value added by the employment of labor and capital. The various methods of calculating net VAT liability will be discussed in Chapter 2.
Before the widespread use of multistage VATs, some countries imposed single stage consumption taxes. Single stage taxes at the retail level still are used by almost all states in the United States and by several provinces in Canada (and formerly in Sweden). More commonly, a single stage tax is imposed at the manufacturer’s (Canada formerly) or wholesaler’s level (Australia before its GST).
III. DIRECT AND INDIRECT TAXES ON AN INCOME OR CONSUMPTION BASE
A. DIRECT AND INDIRECT TAXES
Direct and indirect taxes can be imposed on an income base or consumption base. But what is the distinction between a direct and indirect tax?
Taxes customarily have been classified either as direct or indirect taxes. “A direct tax is one that is assessed upon the property, business or income of the individual who is to pay the tax. Conversely indirect taxes are taxes that are levied upon commodities before they reach the consumer who ultimately pay[s] the taxes as part of the market price of the commodity.”18 This distinction, based on the incidence of the tax, has been criticized because “modern economic theory” points out that income taxes (considered a direct tax) may be shifted.19
According to J. S. Mill’s classic economic principles, the distinction between direct and indirect taxes relates to “whether the person who actually pays the money over to the tax collecting authority suffers a corresponding reduction in his income. If he does, then – in the traditional language – impact and incidence are on the same person and the tax is direct; if not and the burden is shifted and the real income of someone else is affected (i.e., impact and incidence are on different people) then the tax is indirect.”20
In the field of international trade, an Annex to the World Trade Organization agreement defines “direct taxes” as “taxes on wages, profits, interests, rents, royalties, and all other forms of income, and taxes on the ownership of real property” and “indirect taxes” as “sales, excise, turnover, value added, franchise, stamp, transfer, inventory and equipment taxes, border taxes and all taxes other than direct taxes and import charges.”21
The direct versus indirect tax distinction has legal significance in countries subject to the World Trade Organization rules.22 Under the SCM Agreement,23 which is Annex 1 to the WTO, a contracting party is restricted in its ability to grant subsidies to exports or to impose more burdensome taxes on imports than apply to domestic goods.24
According to the WTO rules, border tax adjustments for indirect taxes do not constitute subsidies of exports or disadvantages to imports.25 This WTO direct–indirect tax distinction apparently does not depend on who bears the tax.26 The prohibition against export subsidies may affect the border adjustability of some of the federal taxes proposed in the United States to replace or supplement the federal income taxes, especially proposals for a sales-subtraction VAT that allows a deduction for wages paid.27
In some countries, the imposition of a value added or other tax on consumption raise constitutional issues.28 For example, the province of Alberta, Canada challenged the constitutionality of the Canadian Goods and Services Tax (GST), a European-style VAT.29 The Canadian Supreme Court upheld the GST.30 The Australian High Court struck down a tobacco franchise license fee imposed by a state because Parliament31 had the exclusive power “to impose duties of customs and of excise, and to grant bounties on the production or export of goods....” In that case, New South Wales imposed this tax on duty-free shops that sold retail tobacco to members of the public.32 In contrast, the Federal Court of Australia upheld the constitutionality of the Australian GST.33
In the Philippines, the Supreme Court upheld against a constitutional attack, congressional changes in the VAT that included the grant of authority to the President to raise the VAT rate under special circumstances.34 In some cases, the nation’s constitution must be amended to give a level of government power to impose a tax previously the province of another level of government.35
The United States does not have a federal sales tax or VAT. Nevertheless, there have been academic discussions about the constitutionality of a federal VAT or other consumption-based tax to replace or supplement existing federal income and payroll taxes.36 The issue under the U.S. Constitution is whether any proposed consumption tax is a “direct tax” that must be apportioned among the states on the basis of population.37 There is no significant argument that a European, New Zealand, or Japanese VAT discussed in this book would constitute an unconstitutional direct tax if it were enacted by the United States Congress.38 Even if some of the VAT, due to competitive pressures, were borne by the seller, the indirect VAT would not thereby be transformed into an unconstitutional direct tax.39
B. INCOME AND CONSUMPTION BASE FOR TAX
Thomas Hobbes, in his Leviathan, advocated consumption as an appropriate base for taxation. In his view, people should pay tax based on what they consume (withdraw from society’s limited resources) rather than on what they earn in income (contribute to those resources through their labor). Both receive the protection from the government.40
Income and consumption can be viewed as different aspects of “consumption” in a broad sense. In this respect, income represents the potential power to consume and consumption represents the exercise of the power by consuming goods and services. An annual tax on individuals can be imposed on an income base (the hybrid income-consumption base is used to impose the individual income tax in the United States) or on a consumption base.
Consumption-based taxes can be imposed on or collected by business, its workers, and individuals.41 If the tax is imposed on business, it can be measured by sales or by the value added by business firms at each stage of production and distribution. The tax (like the flat tax discussed later in this book) can be imposed both on business and its workers. Under this form of tax, the base for business is sales less both tax-paid purchases and tax-paid wages. The wage portion of the value added base then is taxed to the wage earners and reported on returns filed by them. If a consumption-based tax is imposed only on individuals, the tax base is income less savings.
As discussed earlier, taxes can be classified as direct or indirect taxes. Direct taxes imposed on an income base include the familiar individual and corporate income tax and the payroll taxes. A direct tax like the income tax imposed on individuals can be imposed on a consumption base by removing returns to capital (such as interest, dividends, and capital gains) from the tax base.42 For example, a personal expenditure tax was used briefly in India and Sri Lanka and was proposed in the United States in 1995.43 Many forms of indirect taxes can be levied on a consumption base, including selective excise taxes, a turnover tax, a single stage sales tax (such as a manufacturer or a retail sales tax), or a multistage sales tax like a value added tax.44
Unlike the individual income tax imposed on an income or hybrid income-consumption base, consumption-based taxes imposed on transactions (like the VAT) cannot be tailored to individual circumstances. As a result, comparing the individual income tax with a European-style VAT, the individual income tax is more flexible as a tool to achieve progressive taxation.
This book does not discuss the politics of raising revenue with an income-based tax or a consumption-based tax, or both, but includes the following thoughts on the importance of considering spending as well as taxation as part of fiscal policy.
One complaint about a VAT is that it is a regressive tax – the tax represents a larger percentage of the income of a low-income household than a high-income household. One response to this argument comes from the noted economist John Kenneth Galbraith, who focuses not only on the incidence of the tax but the combined effect of the tax and how its revenue is spent:45
The relation of the sales tax to the problem of social balance is admirably direct. The community is affluent in privately produced goods. It is poor in public services. The obvious solution is to tax the former to provide the latter – by making private goods more expensive, public goods are made more abundant. Motion pictures, electronic entertainment and cigarettes are made more costly so that schools can be more handsomely supported. We pay more for soap, detergents and vacuum cleaners in order that we may have cleaner cities and less occasion to use them. We have more expensive cars and gasoline so that we may have more agreeable highways and streets on which to drive them. Food being relatively cheap, we tax it in order to have better medical services and better health in which to enjoy it. |
It is proper that a portion of the revenue obtained from a VAT be set aside for the design and implementation of the spending measures, whether they be food stamps, subsidized rents, or other social welfare measures. Thus, to the extent that a value added tax increases prices of goods that poor people buy, it is proper for public policy to provide relief through public spending measures tailored to the needs of those targeted for relief. The best modern brief statement of this policy comes from the Fiscal Affairs Department of the International Monetary Fund:
Fiscal policy – taxation and spending – is a government’s most direct tool for redistributing income, in both the short and the long run. However, the effect of redistributive tax policies, especially in the face of globalization, has been small. Policymakers should focus on developing a broadly based, efficient, and easily administered tax system with moderate marginal rates. Although the primary goal of the tax system should be to promote efficiency, policymakers also need to consider how to distribute the burden of taxation so the system is seen as fair and just. |
Advocates of consumption-based taxes claim that income-based taxes discourage savings by double taxing it. Richard Goode disagrees:47
Saving is an individual decision about the use of income that does not diminish the saver’s capacity to bear taxation. Saving itself does not attract tax. What an income tax does strike is the additional economic resources that a saver gains by lending or investing. In this respect, the return on savings is treated exactly like wages or any other accretion to one’s command over economic resources.48 Goode concedes that consumption taxes encourage savings, “which is especially desirable in developing countries. Under a consumption tax, the net return that can be obtained on income that is saved and invested is higher (in relation to the amount of immediate consumption foregone) than it is under an income tax. With comparable tax rates, the difference is due solely to the fact that postponement of consumption also postpones payment of a consumption tax but does not postpone payment of an income tax.”49 |
Figure 1.1 illustrates the income and product flows for income and consumption tax bases. Table 1.3 and its acccompanying notes show the factor payments by firms to households and the varying tax bases of firms under retail sales, value added, and turnover taxes.
Figure 1.1. Income and product flows in relation to income and consumption bases
| Image not available in HTML version |
| Tax bases of households | Tax bases of firms | |||||||||||
| Income | Sales price – goods | Value-added by firms | ||||||||||
| (factor payments from firms to households) | Retail sales of | Sales | ||||||||||
| Pfts paid | consumer good | consumer | Income | GDP | ||||||||
| Total | Wages Paid | out | Rent paid | Expenditures | & services | & cap goods | C-type | type | type | Turnover | ||
| Firm I | * | 15 | 4 | 1 | 20 | 20 | 20 | 20 | 20 | |||
| Firm II | (2-1) | |||||||||||
| * | 10 | 1 | 3 | -5 | 14 | 15 | 15 | |||||
| Firm III | * | 25 | 3 | 2 | 45 | 45 | 30 | 30 | 30 | 45 | ||
| Households- inc.side | 64 | wages recd 50 | Pft recd 8 | rent recd 6 | ||||||||
| Households- expend.side | 45 | |||||||||||
| Total | 64 | 50 | 8 | 6 | 45 | 45 | 65 | 45 | 64 | 65 | 80 | |
* Assumes all firm earnings paid out as profits, with no retained earnings: the base for an “income tax” on firms would be 8 (pft to households), which is gross (65) less the sum of depreciation (1), wages (50), and rent (6).
Notes to Table 1.3 and Figure 1.1
1 The taxes on households, whether on income or expenditure, can be readily personalized and made progressive; this is not so for the taxes on sales.
2 The value added taxes are not a separate category of taxes for most purposes; they are different ways of doing what is now done through other sales taxes. Thus, the consumption-type VA tax may be regarded as an administrative alternative to a retail sales tax and should be judged on administrative grounds. The income-type VA tax may be regarded as an administrative alternative to a proportional income tax on all factor shares, or as an alternate to a sales tax that covers capital as well as consumer goods with an allowance for depreciation.
3 Tax concessions to capital (to spur economic development) may be examined under both income and sales taxes. If an income tax covers wages only, instead of both wages and profits, there is an obvious concession or favor to capital. Similarly, if a sales tax covers only consumer goods and not both consumer and capital goods, there is a favor to capital. Which concession is greater, other aspects being equal? In the long run a tax concession to savings is analogous to or the same as one to capital goods. Both sales taxes and income taxes can be designed, in effect, to exempt savings, one by providing exemptions to certain income and the other by providing exemptions to certain expenditures.
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